Behavioral Foundations of Corporate Culture

Ernst Fehr is Professor of Economics at the University of Zurich. This post is based on a recent paper by Professor Fehr.

Talking about corporate culture has become quite popular in the business world. But why should companies care about corporate culture at all? Why do “soft” concepts like culture matter? Can’t companies simply rely on “hard” economic forces—the value of clear and efficient institutional rules and their associated financial incentives?

Corporate culture is important because human behavior is always co-determined by the set of social norms that prevail in a company and are the core of its culture. It is in the company’s interest to shape these norms through a cooperative culture that mobilizes employees’ voluntary cooperation in the pursuit of the firm’s overall goals. Our research provides behavioral foundations for cooperative culture, based on important scientific insights from experimental and behavioral economics as well as from contract economics.

In particular, contractual incompleteness, the imperfections of centralized monitoring, and the limits to contract enforcement naturally constrain firms’ ability to regulate and direct their employees’ behavior. This causes severe free-rider problems because employees have many opportunities to reduce their effort without worrying too much about being sanctioned by their superiors. Likewise, there are many situations where extra effort remains undetected and thus unrewarded. In other words, many employees affect companies’ overall performance positively without being rewarded, or negatively without being sanctioned.

A cooperative corporate culture bridges the inevitable gap that arises from the limits of formal rewards and punishments due to incomplete contracts, imperfect monitoring and imperfect verifiability. A cooperative culture makes it more likely that employees will work diligently even if their behavior cannot be observed, that they will take initiative to improve the firm’s operations even if there is no immediate reward, and that they will provide constructive feedback when their colleagues violate normative behavioral standards. In short, a cooperative corporate culture mobilizes employees’ “voluntary cooperation”—which is defined here in an encompassing way and goes far beyond the narrow notion of “people simply coordinating their activities” or “working together”—in the pursuit of the firm’s overall strategic goals.

A large body of powerful evidence (summarized in Fehr & Schurtenberger 2018) indicates that typically a considerable majority of the people is willing to follow cooperative norms at least partially if they believe that other people and, in particular the top leaders, will also comply with the norms. An important requirement for the legitimacy and attractiveness of cooperative norms is that their behavioral prescriptions transparently increase the firm’s overall value and that these cooperation gains are distributed such that all company stakeholders, i.e., also the employees, benefit from them.

However, as a firm’s workforce is typically composed of people with different propensities for voluntary cooperation, it is inevitable that some employees will free ride on others’ efforts if sanctions do not enforce rules and norms—and the failure to comply with norms has the tendency to spread if appropriate measures do not constrain it. Moreover, forces similar to those that lead to contractual incompleteness and imperfect monitoring also limit the centralized enforcement and sanctioning of norms. For this reason, peer feedback and peer sanctioning are indispensable requirements for implementing and enforcing a cooperative culture.

A large body of persuasive evidence (summarized in Fehr & Schurtenberger 2018) also shows that peer feedback—that can range in practice from prosocial encouragement to nonverbal gestures of disagreement to outright criticism for non-compliance—is a powerful driver of human cooperation. Yet, to operate in the long-run interest of the company peer feedback itself needs to be normatively regulated, i.e., the type and strength of peer feedback and the conditions that should trigger it need to be part of the company’s norms. Thus, the conditions for the effectiveness of peer feedback are optimized when it becomes an integral part of a company’s corporate culture.

What is the best way to implement a cooperative corporate culture? The above considerations imply that the mere proclamation of abstract values—such as integrity, loyalty, or commitment—does not suffice. Values need to be translated into clear and simple behavioral prescriptions that are integrated into everyday behaviors that are encouraged and enforced by both management and the employees themselves. And above all, the behavioral prescriptions need to have normative legitimacy, i.e., there has to be a transparent case that they are consistent with a society’s overall value system, lead to an improvement in overall company performance and are associated with a distribution of the gains from cooperation such that all involved parties benefit from it.

In solving practical corporate culture problems it has proven to be useful to classify them along two dimensions—the “willingness to cooperate” and the “awareness of the overall positive effects of cooperation”. In other words, one first needs to empirically measure (i) employees’ overall willingness to cooperate with the company and (ii) their awareness about the positive aggregate gains from cooperation. On the basis of this knowledge one can then, second, develop an appropriate set of changes in the company’s incentives and the necessary behavioral prescriptions including the optimal feedback structure for the mobilization of peer support.

If, for example, the average willingness to cooperate and the awareness of the positive side effects is large, a communication campaign plus a few behavioral nudges—such as reminders—may change the culture for the better. However, if the average willingness to cooperate is low and employees have little awareness of the gains from cooperation, a more thorough set of measures that combines communication campaigns with changes in normative prescriptions and financial incentives for cooperation will be necessary.

However, whatever the road to a cooperative corporate culture will be—once successfully established it promises benefits for all company stakeholders.

The complete paper is available for download here.

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